Monday, January 10, 2011

Logitech and a divergence into days payable outstanding, Dell, Apple, and macroeconomic conditions in China

Stableboy Selections (a blog I should read more often) provides us with a fairly simple case for shorting Logitech. After joking about their domicile (Apples Switzerland) he points out the obvious - laptops are replacing desktops - pads and phones are replacing both of them. Logitech sells peripherals. The new technology (along with things like Google speak-to-search) will reduce the need for peripherals. Peripheral sales should fall year-in-year-out - they have done so at Logitech.

Eventually this suggests Logitech will look like Radio Shack - a company that got rich selling cables for your computer and TV and eventually shrunk into (near) oblivion. The first of two bottoms (in the stock at least) was marked by The Onion doing a mock interview where the CEO could not figure out why they were still in business.

If the desktop is doomed so are its peripherals - and along with my absurd collection of cables (firewire anyone) I now have a collection of mice, keyboards, video-cams and the like. My shop is my attic.

Given Logitech trades at a trailing PE of 22 it looks like an attractive valuation-business obsolescence short.

Alas if this business were as easy as ripping off other people’s ideas we would all be rich. So I went to work reading Logitech’s accounts. There are some upsides - first and foremost is Google TV (“the most important product launch in our history”). I am not sure Google TV is getting much traction (but they have a really complex remote control to sell and even that will become another Android app). More notably they had a really good quarter - enough of a good quarter that it spelled "turnaround". Just as The Onion marked a bottom in Radioshack I was worried that Stableboy would mark a (the?) bottom in Logitech.

I just could not work out why peripherals would have a good quarter. And if it was a good quarter I could not figure any reason why sales should start motoring upward. The trend towards lower peripherals sales plain - and the company's contrary prediction is strange. However the company does predict turnaround.

My first reaction was that the company was channel-stuffing. (Increasing the speed at which you deliver to just-in-time retail can produce sharply rising sales at the expense of annoying your customers and sharply falling sales next quarter.) Channel-stuffing would have been a great short thesis (and Stableboy hints at it) but it does not look supported by the data. Days receivable rose - but only in proportion to sales. (They rose from $260 to $305 million - both 47 days.)

Inventory turns dropped (why I do not understand). But what really jumped out at me was that payables rose to 90 days from 71 days. This company was not paying its suppliers. Ninety days outstanding almost destroyed David's Holdings (as per my last blog post). Its a pretty big tell - or so it seems to someone who is used to the 35 days of retailers.

But alas 90 days is not so startling. Apple is at 80 days at the end of year (and has been higher). Dell is at 81. And the disease is widespread - for instance the Japanese optical companies (Canon, Nikon) are at 80-90 days.

Dell is particularly instructive. The company collects its cash in advance from customers and runs on negative working capital. The business has always been funded by borrowing from suppliers. Its just that the scale of the loan has increased with monotonous regularity. Days payable outstanding was 56.1 days a decade ago - then 66.9, 69.4, 71.3, 73.4, 74.8, 77.1, 80.1, 71.8 and 81.2 days. Dell just screws its suppliers a little bit more every year. It shows more cash generation than is real. It makes itself look better than it actually is.

Dell however is a declining business. Apple which is clearly not declining does it too.

Ultimately this is bad business practice. It stresses suppliers - it costs them money chasing you up. It builds distrust. Yet Apple does it - and the reason is obvious. Because it can. Apple has power and it is not afraid to (ab)use that power.

This leads me to the real point of this post. The macroeconomic conditions in China are changing dramatically. Labor shortages are a serious problem. We are beginning to see press stories about difficulties in getting things produced and companies bringing production back to the USA. What this presages is a change in power between the Western giants and their Chinese manufacturers. Apple behaves badly because it can - but that power probably does not exist in the long run for Dell or Logitech and the loans that these companies have taken from their suppliers (loans that are a meaningful part of their cash balance in some cases) are going to have to be repaid.

It is logical when you think about it. Inflation in the US is 1 percent plus or minus 2 percent. Its probably over 10 percent in China. Slow payment thus benefits the Americans relatively little but costs the Chinese counterpart a lot. Chinese inflation and labor shortages should cause supply chains to speed up.

Cisco, Samsung and other companies that have kept the supply chain sweet should be fine. Apple should be fine too - its bills to suppliers are trivial compared to cash balances or profits.

But hey - we did short some Logitech. It really is not so good for them. 90 days really is a problem - even if they don't know it yet. Their business practice stinks and it will come back and bite them. And it will bite many other companies too.

10 comments:

WB
said...

fwiw -- managed to destroy a laptop screen travelling so instead hooked it up to the t.v. in my home gym and found that all i needed to browse while on the treadmill was. . .a wireless mouse. . .(supplied, as it turns out, from logitech)i suppose there will be lots of fantastic things that true internet tvs will do, but for my world if my choice is upgrading a perfectly good Samsung flat panel OR buying a $40 logitech mouse, then i am going for the latter. . .

A problem with your (and Stableboy's analysis) of Logitech is that it's core premise ... that the move to laptops and smartphones will reduce the market for peripherals ... is questionable.

The emergence of the iPhone/iPod led to a substantial market for docks - one in which Logitech is a significant player.

Likewise, there is a growing set of "laptop specific" peripherals (e.g. cooling lap-desks and USB docks). And as new technologies are enabling a "one cable" USB dock viable, demand for keyboard and mouse sets for docked laptops and smartphones can be expected to rise (and that isn't even counting the fact that even TVs now come with a keyboard option).

I have no position either way, but a couple of points.No one should ever look at trailing multiples.On Mar-11 YE EPS expectations of $1.21, the stock is on 15x.Ex the current cash, that's 13.6x or given reasonable cash generation over the next 12 months of another $1 per share means 12.8x.22x it is not.

The inventory build is intriguing.I always look on a quarterly basis versus previous years to avoid the high seasonality issues.So for Sep-10 Q, inventory was 86 days of the annual run-rate of COGS up A LOT from the 63 days of the year before, AND the previous 4 years average Sep-Q of 66 days.

This was why their Gross Margin looked awesome (37.3% vs. 30.5% in the previous year). They were running flat out on production and building inventory.

Why?Well perhaps they were looking towards a gangbuster Dec Q.Or perhaps they wanted to flatter the margin.

We won't know until they tell us exactly how great their Xmas performance was on Jan 26.(Although I won't be getting up at 3am to find out in real time...)

On the "good Q for peripherals" I think it is just a bounce back towards "normal".The beat was mostly mice and keyboards and if you look at the previous run-rates, they are still way off Sep-08 numbers.Mice $154m vs. $221mKeyboards $95m vs. $138m

While the long term trend is clearly negative for mice and keyboards for all the obvious reasons, you need to be confident that the current "return to normal" bounce back isn't too much!Of course 2008 is likely to be the peak for those categories but I suspect 2010 will be the medium term trough.

You still have laptop cannibalisation requiring a retail mouse/keyboard purchase rather than OEM (consumer wants a kind of laptop docking station to replace old desktop). And that favours LOGI.The iPadification of the world suits Logitech too since tablets need peripherals as much as or more than laptops (speakers for example).Remotes are too small to matter.

I am a former shareholder of LOGI - I sold my stock late in 2008 after owning it for a number of years. Repeat: I dont own the stock. I'm not interested in owning the company today, but I'll play devil's advocate for the fun of it.

I think you might be overestimating just how quickly their markets are declining, if they are even declining at all. I've heard multiple arguments over the years for being short: desktop sales are declining, keyboards/mice/speakers are commodity product, webcams are being integaretd, and now touch screens are replacing mice.

1) How has LOGI managed to increase sales of standalone keyboards/mice by ~5%/year over the last 5 years while desktop sales have declined by about the same amount? Clearly, there is some growth opportunity here. Your "desktop is doomed" article is an ancient argument to short the stock.

2) Dont you worry about the threat of new categories? Tablets are as much an opportunity as a threat. Did iPods destroy the PC speaker business? No, it actually opened up the ultra-high growth dock market.

3) Are LOGI's markets really all that competitive? Go to a Best Buy and see for yourself. They mainly compete with MSFT, who for reasons I still cant figure out, make keyboards/mice/webcams. In most categories, LOGI only has one main competitor, and LOGI tends to dominate shelf space. LOGI is getting on average a very respectable 35% gross margins.

4) What about LOGI as a natural acquirer for interesting CE companies looking to go to the next level? They bought Intrigue (now the Harmony remotes) for a mere $30m in 2004. I estimate it's earned $80-100m since. They bought Labtec for $35m in 1998. I estimate it's earned $300m since. They've done good deals in the past that tend to pay for themselves rather quickly.

5) Google TV is and was a sideshow. The stock might have ran into the product release, but nobody realistically expected anything.

6) The Remote apps, in a word, suck. I have an iPad and I've tried them. They're annoying. They're slow. What if my wife is using it? What if it's in another room? What do I tell the babysitter? These are simply not remote killers, never.

7) The company generates a considerable amount of free cash flow. I dont agree with what they've done with it lately, but historically they've had about 10% free cash flow margins, and they bought back stock and did shrewd, small acquisitions. Plus, the balance sheet still shows no debt at all and almost $2/share in cash.

In short (no pun intended), this is a pretty good company. I'd short it if the valuation got absolutely ridiculous, otherwise I'm content watching from the sidelines.

No opinion on Logitech or others in this sector, but I think you are quite right to tie this back into the Chinese macro. The short version, I think, is that Chinese banks (effectively underwritten by government) are happy to underwrite export receivables. This is largely funded by Chinese depositors getting low interest rates.

You've chosen to focus on the effect on supplier relationships, but I think the key point is that the Chinese manufacturers are living on razor-thin margins. A change in finance terms will either kill (some of) them, or drive up prices - another way Chinese prices for export could go up without the dollar/yuan rate actually moving.

Looking for stocks to short because Smartphones are putting them out of business? Go and have a quiet word to Gerry Harvey!

The blow ups at Circuit City and Best Buy seem to have passed him by unnoticed. He seems to think it's a combination of local tax and ebay sellers killing him, yet the bloke still does not have a web site that allows on-line purchases.

I presume the micro-in-store-franchise business model he's stuck with means national on-line sales would gut his franchisees sales and have them walk.

With Smartphones representing a 10-15 in 1 product, dumb pipes like Harvey Norman simply have no value added with which to continue to exist (unless you call being a loan shark "value added")

Hi JohnEnjoy your blogYou have commented on a subsequent post that no one has commented on your China comments - I think its because no one understands what you are getting at there. I certinaly don't. Having completed the CFA, I am no financial dummy either. If you could elaborate a bit further that would be great, cheers

"Ultimately this is bad business practice. It stresses suppliers - it costs them money chasing you up. It builds distrust. Yet Apple does it - and the reason is obvious. Because it can. Apple has power and it is not afraid to (ab)use that power"

I am working in the logistic freight forwarding company and our company start to analize the working capital including this DPO and they are asking me to increase DPO increasing DPO one solution is not to pay suppliers by 60 to 90 days can I really do this well i can do it I will not pay but how will I expalin to the my boss that i will not be responsible for any stop shipments especially that we are in the arab region

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